An Analysis of the Market Reward and Torpedo Effect of Firms that Consistently Meet Expectations

Abstract

The goal of meeting analyst expectations has developed into a standard benchmark for firms. This goal extends to consistently meeting analyst expectations in consecutive fiscal quarters. Using a sample of firms that consistently meets expectations, I find evidence that akin to the market reward associated with consistently meeting expectations, there is a matching large negative stock price reaction when the firm eventually misses expectations. The market reward is proportionate to the number of quarters in which the firm consistently meets expectations. Furthermore, the negative reaction to a break in the string is inversely related to the number of quarters in which it met expectations. This torpedo effect reverses some of the premium accumulated from consistently meeting the forecast. While the majority of firms do not resume the string of meeting expectations, I find that, consistent with the emphasis placed by managers on maintaining the string, the likelihood that a firm resumes the string increases with the length of the previous string and also with the firm's growth. These findings provide additional insight into the motivations and mechanisms of firms that consistently meet analyst expectations.